The LBM Industry, Disrupted

May 19, 2017 Alex Moazed

Building materials will be ruled by a marketplace. Will the industry let it be Amazon?

Over the past couple years, Amazon has been making a huge splash in B2B distribution. After it stood up Amazon Business as a separate unit in April 2015, the company labeled the effort a “must win” in public court documents and has been steadily and quickly building a marketplace for B2B goods.

Amazon views B2B as a likely “fourth pillar” alongside its consumer retail marketplace, Amazon Prime, and Amazon Web Services, and it’ll likely carry Amazon to that fabled trillion-dollar valuation.

While Amazon Business has primarily targeted more commoditized industries like industrial supply, it has also started to make some headway into building materials. Soon enough, you can expect it to have a much stronger presence in the industry.

Why? Simply, the building materials industry is incredibly fragmented—some of the largest firms in the industry don’t even operate in all 50 states. And it’s still heavily populated by regional players and independent dealers. Supplyside fragmentation makes it much easier for a marketplace to get a foothold in a new industry.

Paired with the commoditization of many common product offerings, this high level of fragmentation makes the building materials industry incredibly vulnerable to disruption from a well-funded entrant like Amazon Business.

The Applico team recently worked with a multibillion- dollar B2B distributor on devising the right strategies for beating Amazon Business and uncovered a huge opportunity for incumbent firms in adjacent industries to embrace similar marketplace approaches.

It’s Happened Before

To understand the threat, it’s helpful to look at what happened to Circuit City. The now-defunct electronics retailer was #2 in the market and didn’t think much of Amazon—so little, in fact, that in 2001, it listed many of its products on the newly launched Amazon Marketplace in lieu of building out its own e-commerce efforts.

In 2006, Circuit City reached its peak, with tens of thousands of employees, $12 billion in sales, and a share price trading at $30. Executives believed that customers would always go to their stores to purchase TVs because the quality couldn’t be matched or validated when buying online.

Regardless of whether Amazon could sell TVs turned out to be a side note. (Eventually, it did.) Either way, Amazon was able to sell the small, easily shippable items like remotes, MP3 players, headphones, and a multitude of electronic accessories.

This shift to online sales, primarily on Amazon, steadily chipped away at Circuit City’s margins over a mere seven years, leading the retailer to file for bankruptcy in 2008 with shares trading at a dime apiece.

While consumer electronics and construction materials are quite different industries, their distribution can be disrupted by a marketplace in very similar ways. The antagonist then and now is the same: Amazon.

While Amazon Business may not start selling drywall or concrete mix by the tonnage anytime soon, it can easily distribute the smaller goods, such as hand tools and parts—and eat into established dealers’ and distributors’ margins.

Circuit City Final Days

It Can Happen Again

As it turns out, this sea change has already begun. Bosch, one of the world’s largest toolmakers, maintains a branded page on Amazon Business, purveying its products directly through its digital marketplace, leaving out the traditional suppliers in these transactions. Many other large manufacturers also are selling direct on Amazon.

The attraction is even greater for small suppliers. To these companies, a marketplace offers a way to scale their business that they wouldn’t have access to otherwise. In a fragmented industry, these small suppliers are some of the fiercest regional competitors for many of the larger distributors. Consolidated in a marketplace, this competitive threat increases by an order of magnitude.

In our financial analysis of established distributors in the industry, we found that most top distributors facing a successful marketplace entrant could lose the majority of their EBITDA over the next half decade. Our analysis in other industries, such as evaluating Grainger in MRO/Industrial Supply, has found similar results.

In fact, the Applico team correctly predicted that Grainger would begin declining and it missed its Q1 2017 earnings projections, which no one else expected. The MRO supplier’s strategy of pricing adjustments is clearly not going to work.

The same fate will befall most other building materials companies that choose to take on Amazon directly with their existing business models. Successful marketplaces tend to erode traditional competitive advantages over time and become the dominant players in their respective markets. Amazon Business is primed to do just that.

What To Do Now

Smaller companies, mom-and-pops and regional firms need to weigh their options carefully. They can’t hope to scale up to compete with their larger counterparts; it would take years and billions of dollars to get there.

Yet a new marketplace brings opportunity. In many industries, entirely new businesses have been built by capitalizing on the opportunity that a new marketplace offers.

From eBay Stores to Amazon merchants to entire villages in China built on selling products through Alibaba, there’s now a long history of marketplaces enabling new suppliers to thrive or for existing suppliers to expand rapidly by capitalizing on an influx of e-commerce revenue and a much leaner cost structure.

In the building materials industry, these smaller competitors can attach themselves to a marketplace, which would empower them to reach a larger market for very low marginal cost. A company based in Florida could suddenly find itself filling orders anywhere in the country without the need to market to those customers directly or build out its own e-commerce capabilities.

The story for the largest companies is very different. For them, Amazon Business represents a serious threat. Yet there also is tremendous opportunity ahead for these competitors. The largest firms have the opportunity to create a marketplace of their own, leveraging their already established relationships and industry knowledge to leap ahead of Amazon and prevent it from taking over the industry.

While Amazon will likely succeed as a generalist marketplace in B2B, there is still room for vertical-specific marketplaces to flourish alongside it. This is especially true in a market like building materials, where industry-specific challenges can be better solved by a more focused marketplace.

However, if the industry waits too long to respond with a marketplace of its own, it will likely be taken over by Amazon Business. In this scenario, large existing distributors would be forced to drop a huge sum on acquiring a marketplace startup and become, in a best-case scenario, second place to Amazon.

This is exactly what happened to Walmart. The retail giant didn’t take its marketplace efforts seriously for nearly a decade. Last year, Walmart admitted its mistake by spending some $3.3 billion to buy Jet.com. Most B2B distributors won’t have that luxury.

For large distributors facing the threat of Amazon Business, it’s no longer a question of “if.” It’s a matter of “when.” The longer they wait, the harder and more expensive it will become to avoid becoming the next Circuit City. If they act now, they have the opportunity to beat Amazon at its own game.

The key is to embrace the same marketplace model Amazon is using to dominate B2C e-commerce and transform B2B. Large distributors need to build an independent subsidiary that will list products from distributors big and small, the same ones currently viewed as competitors today, and ensure that orders are fulfilled indiscriminately.

In other words, today’s competitors are likely tomorrow’s collaborators.

It may sound fantastical now, but Amazon will scoop up the small distributors looking for a low-margin path to fast growth, which the marketplace model will provide. In so doing, large distributors will see their margins shrink, then vanish as Amazon delivers more competitive pricing. Again, look at Grainger for proof of this phenomenon.

Incumbent building materials distributors have the brand value, industry knowledge and established relationships that can provide incredible competitive advantages over Amazon. All they need to do is get a little creative with their business strategy and build a marketplace within the industry and prevent Amazon from taking over.

In the first 24 hours after its missed earnings call, Grainger lost over $1 billion in market capitalization, or about 11%. Embrace digital transformation with a marketplace and not only avoid Grainger’s pain and survive Amazon’s disruption, but transform the industry and become a modern monopoly.

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